By Pawan Khatter and JayantaKalita
With increasing globalization and expanding markets, it is now commonfor domestic airlines in India to tie-up with international airlines. India is becoming an attractive aviation industry destination, given increasing domestic and international traffic, a rising addressable market and robust projected economic growth.The recent opening of this sector by allowing foreign airlines foreign direct investment (FDI) of upto 49% in Indian airlines has resulted in a considerable increase in activity in this space.Businesses world over are making long-term plans of investing and doing business in the India. The same is true of the Indian aviation industry.
According to the latest statistics released by Airport Authorities of India for fiscal year 2013, India is currently the ninth largest civil aviation market, handling 121 million domestic and 41 million international passengers. Today, more than 85 international airlines operate to India and five Indian carriers connect to over 40 countries.The Indian civil aviation market has only a tenth of the passenger traffic of United States even though only one per cent of the Indian population hasso far opted for the skies as a medium of transportation.
A special report released by the International Air Transport Association in October 2012 states that if Indians begin to travel with the same frequency as Americans, the years ahead could see the Indian market boom beyond the two billion passengers per year mark.The growth potential of the Indian civil aviation market is clearly enormous.
However, the industry faces various challenges; foremost among them is the impact of taxes. There are several types of taxes (both direct and indirect) applicable on the aviation industry.
Taxes On Profits
The domestic tax laws of India provide for a deemed basis of taxation (as opposed to actual basis) where 5% of the amount received by a foreign carrier from passenger fares and freight receiptsby way of air transport from any place in India shall be deemed income of such foreign carrier.International transportation has been regulated by agreements as a matter of international co-operation between countries permitting aircraft of other countries tofly in their respective jurisdictions on a basis of mutuality.
The Indian government has entered into double taxation avoidance agreements(DTAA) with various countries to provide bilateral relief to taxpayers between the country of residence and country of source of income. Where a specific provision has been made in a DTAA entered into by the Government of India with the Government of a foreign state,that provision shall prevail over the general provisions made in the domestic tax law.Article 8 of a typical DTAAprovides for taxation of profit from the operation of aircraft in international traffic and grants the taxing rights to the country in which place of effective management of airline is situated i.e. the place of residence.
Foreign carriers earn revenues in relation to their international air traffic to and from India derived from ticket sales and cargo traffic. Also, a few foreign airlines, having significant international traffic to and from India have, over the years, established appropriate infrastructure in India for maintenance and repair of its aircraft. These airlines make certain recoveries from other international airlines that, from time to time, use the infrastructure facilities in India, either because these airlines do not have similar resources or to augment their existing facilities.
These facilities are generally related to ground handling and engineering services (repairs, maintenance etc.) provided in pursuance of a reciprocal pooling arrangement envisaged by the International Airlines Technical Pool (IATP) which has been entered into by most airlines worldwide. These activities are ancillary, incidental and supplemental to the airline business of operating aircraft in international traffic to and from India.As member of the IATP, any foreign airline providing ancillary services in India to other IATP member airlines receives similar services from other airlines worldwide
The issue arises, whether all income from operation of aircraft in international traffic, including income from ancillary, incidental and supplemental services such as provision of engineering and ground handling services under a pooling arrangement to IATP members are exempt from tax in India under Article 8 of the DTAA. This issue is unfortunately a subject matter of long standing dispute with the Indian revenue authorities, with contradictory decisions of tax courts in India. The matter is currently pending adjudication by the High Court of Delhi and has not yet reached finality.
Profits covered under Article 8 should consist in the first place of profits directly arising from transportation of passengers or cargo by airlines in international traffic. However, as international transport has evolved, air transport enterprises invariably carry on a large variety of activities to permit, facilitate or support their international traffic operations. The article also covers profits from activities which are not directly connected with the operation of the enterprise’s aircraft in international traffic as long as they are ancillary to such operation.
Contemporary tax treaty interpretation is to include ancillary, auxiliary, closely related, supplementary and incidental activities, which is applied by taxing authorities in general.
VAT On Sale Of Ticket – Taxation Of Ticket Sales On International Travel
An ad valorem (fixed percentage on value) tax on sale of tickets for air travel of passengers is levied on the airline operator. Such a tax is internationally known as a ticket tax. Such taxes may be levied either as a VAT (Value Added Tax, which works on the principle of tax on value added in the supply chain) or GST (Goods & Service Tax, a comprehensive tax on supply of goods or services).
In India, a tax by the name of Service Tax is levied on airline operators providing services of passenger travel. Service Tax was initially levied in May 2006 on international air travel of passengers on an ad valorem basis (rates varying between 10% – 12% since 2006). This was later extended to domestic travel from July 2010, albeit at nominal fixed value rate per ticket. To date both international and domestic civil aviation attract Service Tax at an abated rate.
Levy of GST/VAT on international passenger travel is converse from that of India. Globally, the majority of the countries (including European nations, Australia and Canada) either exempt or levy VAT/GST on international passenger travel at zero rates. Many emerging markets like Argentina, China, Korea, South Africa etc. also do not levy VAT/GST on international travel. Thus, many countries have recognized the potential of civil aviation and taxing international air travel as zero rated so as to also avoid tax cascading (a cascading tax is a turnover tax applied at every stage in the supply chain without any deduction for the tax paid at earlier stages).
In 2012, the Ministry of Civil Aviation in India made a proposal to the Ministry of Finance for removal of Service Tax on air tickets on the ground that the policy change would result in economic benefits of ten times the revenue generated by the exchequer. The proposal has been considered to the extent that abatements have been granted to airline operators thus reducing the effective rate of Service Tax. However, the need is for a complete waiver as was envisaged by the International Civil Aviation Organization (ICAO) so as not to tax international air transport services given that such services are provided outside the boundaries of any tax authority.
The Tax-On-Tax Conundrum
Levy of tax on aad valorem basis creates issues regarding the valuation of services. A Service Tax has been sought to be levied by the revenue authorities on the total fare i.e., basic fare, surcharge as well as taxes and the fees component of the ticket. The Indian revenue authorities have been aggressively litigating with carriers demanding Service Tax on the taxes and fees portion of the ticket fare (i.e., departure and other trip charges) which are levied by the governments, government departments and airport authorities of other countries, clearly transcending jurisdictional boundaries. For example, the Indian revenue authorities are seeking to subject to service tax the Customs User Fee levied on arrival of passengers in the United States.
The airlines are contending that they have been designated by governmentsauthorities to collect such taxes and fees from the passengers for administrative convenience only. Such taxes and fees do not form part of the revenue of the airlines. Hence, levy of tax on such amounts is preposterous to say the least.
Tax-on-tax is technically known as the cascading effect which defeats the principle of value added basis of taxation. Moreover, the demand of Service Tax on tax-on-tax is post facto which literally means that the airline would not be in a position to collect it from the passengers and which, in all probability, may not have been accounted as a cost at the time of budgeting ticket fares.
Significant Taxes On Aviation Turbine Fuel (ATF)
Aviation fuel constitutes a staggering 50-60 per cent of the total operating cost of airlines in India. The Association of European Airlines (AEA) members indicate that their fuel constitutes 33 per cent of operating cost.
The pricing and tax regime of the Union and State Governments in India have made ATF significantly more expensive compared to international standards. The pricing of ATF in India is based on international import parity prices. Excise duty is levied by the Central Government on such prices at 8 per cent. In addition, VAT is levied by State Governments which can range anywhere between 4-30 per cent (depending upon the State from where ATF is sold). The resultant incidence of tax on ATF could be in the range of 30 per cent (assuming a VAT rate of approximately 20 per cent). Thus, the price of ATF in India works out to be 60-70 per cent higher than international benchmarks.
The Government has accorded a lower rate of VAT of 5 per cent on the sale of ATF, but that is only applicable on ATF sold to aircraft having a maximum take-off mass of less than 40 tonnes. In effect, this concession is only available to smaller aircraft and turbo-props. The industry has been lobbying with the Ministry of Finance for extendingthis concessional rate of tax on supply of ATF to all aircraft, but has so far been unsuccessful.
Given that the India lacks a comprehensive indirect tax regime (the move towards a comprehensive GST regime has been sluggish), airlines do not have the ability to set off VAT on ATF against their service tax liability.
Even on international travel, the levy of certain taxes is clearly contradictory to the resolutions agreed under the Chicago Convention of 1944 (to which India is a signatory) which requires the signatories to exempt taxes/duties applicable on fuel and lubricants used in the aircraft of other signatory nations. Though the Ministry of Civil Aviation has issued notifications providing for such exemptions, we understand that taxes such as ATF are still levied by many States even on aircraft for international travel.
Other Tax Issues
There are various other tax issues plaguing the aviation industry. Some of these issues include application of a service tax on excess baggage charges and import cargo, and application of VAT or service tax on on-board sale of food and other goods.
Taxes are leviedon virtually all facets of the aviation sector.Given the growth potential of the Indian aviation market, particularly international travel, the Government should view this sector as a revenue generator and rationalize the tax regine to provide a much needed impetus to this industry.
Pawan Khatter and JayantaKalita are Senior Tax Professionals at EY India. They can be reached firstname.lastname@example.org email@example.com.